HP INC quarterly report, Q3 FY2011

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HP Inc. (Hewlett-Packard Company) — Form 10-Q Summary

Business context and reporting period

HP reported its fiscal third quarter ended July 31, 2011, and the first nine months of fiscal 2011. The company operates across Services, Enterprise Servers, Storage and Networking (ESSN), HP Software, Personal Systems Group (PSG), Imaging and Printing Group (IPG), HP Financial Services (HPFS), and Corporate Investments. Unless noted, financial amounts are in U.S. dollars.

Financial performance and position

  • Third-quarter revenue: $31.2 billion, up 1.5% year over year as reported, but down 2.3% on a constant-currency basis. Products contributed $20.4 billion and services $10.7 billion.
  • Third-quarter earnings: Operating earnings were $2.52 billion, or 8.1% of revenue, versus $2.32 billion and 7.6% a year earlier. Net earnings were $1.93 billion, up from $1.77 billion; diluted EPS was $0.93 versus $0.75.
  • Nine-month results: Revenue was $95.1 billion, up 2.6% reported and 1.2% constant currency. Operating earnings were $8.88 billion (9.4% margin), net earnings were $6.84 billion, and diluted EPS was $3.16, compared with $8.18 billion, $6.22 billion, and $2.60, respectively, in 2010.
  • Margins: Third-quarter gross margin declined 0.7 percentage points to 23.3%; nine-month gross margin rose 0.6 points to 24.1%. Third-quarter operating margin improved 0.5 points, while nine-month operating margin improved 0.6 points.
  • Cash flow: Nine-month operating cash flow was $10.24 billion, compared with $8.77 billion. Investing cash outflow was $2.49 billion and financing cash outflow was $5.72 billion. Cash increased $2.02 billion to $12.95 billion. Capital investment in property and equipment was $3.15 billion.
  • Liquidity and debt: At July 31, cash and cash equivalents were $12.95 billion; current assets were $56.28 billion and current liabilities $48.94 billion. Short-term borrowings were $6.67 billion and long-term debt $19.03 billion, for total borrowings of approximately $25.7 billion, up from $22.3 billion at October 31, 2010. HP reported $14.7 billion of available borrowing resources, including commercial-paper capacity and uncommitted lines, as well as $780 million available under receivables facilities.
  • Capital returns: HP repurchased $9.6 billion of shares and paid $605 million in dividends in the first nine months. The declared quarterly dividend was $0.24 per share.

Material changes versus the prior comparable period

  • Growth was uneven across businesses. In the third quarter, ESSN revenue rose 7.5%, Services 3.6%, HP Software 20.0%, and HPFS 22.0%; PSG fell 3.3% and IPG fell 1.3%.
  • Third-quarter segment operating results weakened at Services (earnings down 11.3%), HP Software (down 17.0%) and IPG (down 14.2%). PSG earnings increased 20.9% despite lower revenue; ESSN earnings were nearly flat. HP Software’s nine-month revenue rose 14.0%, but operating earnings fell 17.9%.
  • Third-quarter gross margin pressure reflected lower Services margins, IPG supply-chain and logistics costs, and WebOS-related price promotions. HP cited component-cost declines as supporting PSG and ESSN margins. Nine-month margin gains benefited from lower component costs and a more favorable networking and software mix.
  • Restructuring charges declined to $150 million in the quarter and $466 million in the nine months, from $598 million and $909 million, respectively, in 2010. HP’s enterprise-services restructuring plan had eliminated approximately 5,200 positions by July 31.
  • The cash conversion cycle lengthened to 26 days from 17 days a year earlier, driven by higher days sales outstanding (52 versus 46) and lower days purchases outstanding; inventory days were unchanged at 28.

Outlook, management commentary, risks and unusual items

  • HP provided no numerical full-year earnings or revenue guidance in the supplied filing text. Management emphasized cloud computing, software and higher-value services, operational efficiency, and investment in growth markets.
  • In August 2011, HP announced a recommended cash offer for Autonomy at £25.50 per share, representing enterprise value of approximately $11 billion. The proposed acquisition was subject to customary conditions. HP intended to use cash and debt financing, entered into an £5 billion (approximately $8.2 billion) 364-day bridge facility, and agreed to maintain at least $4.25 billion in cash reserves for the offer process.
  • HP’s board authorized an evaluation of strategic alternatives for PSG, preferring a potential separation. HP expected the evaluation to conclude by the end of calendar 2011 and any plan to be implemented within approximately 12–18 months of the announcement. Credit-rating agencies lowered their outlooks in August while maintaining existing ratings.
  • HP announced it would stop making and selling WebOS hardware. It expected a one-time fourth-quarter fiscal 2011 restructuring and shutdown charge of approximately $1 billion, most expected to be paid in that quarter. HP also planned to assess approximately $1.2 billion of Palm-related goodwill and intangible assets for potential impairment.
  • Third-quarter unusual items included a $143 million charge for WebOS inventory write-downs and expected contractual and purchase-commitment losses. Nine-month SG&A included $310 million of net real-estate sale gains and a $79 million gain on the Halo business divestiture. Tax benefits from discrete items were $145 million in the quarter and $302 million for the nine months.
  • Key business risks include competitive pricing and weaker demand, especially in consumer PCs; execution of the proposed Autonomy acquisition and PSG review; WebOS asset impairment; supply-chain disruption and Japan-related impacts on printing; the announced cessation of software development for Itanium-based servers by an alliance partner; foreign-exchange exposure; and restructuring execution.
  • Contingencies include ongoing tax examinations and approximately $1.9 billion of gross unrecognized tax benefits. HP disclosed investigations related to alleged improper payments involving the Russia GPO transaction and customs-duty notices in India seeking approximately $370 million plus penalties. In Brazil, a postal-service authority imposed a five-year suspension on HP Brazil’s ability to bid and contract; HP sought revocation and interim relief. HP stated that, as of July 31, it did not believe additional material litigation losses beyond recorded amounts were reasonably possible, while noting litigation is inherently unpredictable.

Most important facts for an investor to verify

  • Whether the Autonomy offer closed, its final financing mix and effect on debt, cash reserves, and credit ratings.
  • The outcome and timing of the PSG strategic-alternatives process, including any separation costs or operational disruption.
  • The actual fourth-quarter WebOS shutdown charge and any impairment of Palm-related goodwill or intangibles.
  • Whether Services and HP Software margins recover, and whether IPG supply constraints and Japan-related costs ease.
  • Cash conversion, receivables collection, inventory levels, share repurchases, and total debt after the reporting date.
  • Developments in the Russia GPO investigation, India customs proceedings, Brazil contracting suspension, tax audits, and other material contingencies.